Successful Outsourcing Depends on Critical Factors

Deciding to outsource is a decision that will have long-lasting impact both on your human resources department and on your entire organization. Outsourcing is defined as contracting for outside services that are a necessary part of doing business, but are not core functions. Although the decision to outsource one or more functions to an outside vendor can be a decision that you're tempted to make rapidly because of an urgent need or because you've got too many other areas to juggle already, it's important to take the time to outsource for the right reasons, armed with the right facts to guide you.

The following factors can be critical to making and implementing a successful outsourcing decision:

Make sure that your goals for outsourcing are clear from the outset

Look at outsourcing over the short-and long-term

Consider who will control the outsourcing decision and why

Consider how well your company's culture will support an outsourcing decision

Decide whether it's better for your operation to be centralized or decentralized before outsourcing.

"If your goals for outsourcing one or more functions aren't clear from the start, you can end up with a failed partnership."

Before you make an outsourcing decision, however, you need to ask whether the areas that you want to outsource, such as COBRA administration or relocation, are mission-critical to your organization. These days, many organizations' management teams are re-engineering process functions and are asking themselves if certain areas are essential to their core business. If not, they often outsource them so that they can focus on what they have to do, and let other companies assist by providing the services that they're good at.

In a February 1992 article in Management Accounting, management guru Tom Peters asks, "Could [a function's] output be successfully sold on the open market? If not, subcontract [the] work to firms that specialize in each function, which will almost certainly do it better and more cheaply."

Sometimes a company can simply pay for an outsource vendor to help re-engineer a process. Other times, however, that isn't enough. If a company can't maintain the improvements or devote the management time to a certain area, it may want to consider outsourcing temporarily or permanently to a strategic partner rather than continuing to perform the function internally.

Make sure that your goals for outsourcing are clear.Whether you want to reduce the response time for employees' benefits questions or you want to rely on the expertise of a 401(k) vendor to provide retirement services, it's important to explicitly lay out your goals before making an outsourcing decision.

If you don't, you could be disappointed with the results even as early as a few months down the line, warn the experts. "Some people say, 'I want to outsource because I think I can save some costs.' That's the wrong reason to do it," warns Richard Dole, vice chairman for Coopers & Lybrand's process-management area based in Houston. "You probably will save costs when you outsource because you're [outsourcing] with a company that does it better and faster. But you shouldn't do it [just] to save costs, [because then] you haven't completely gone through the thought process."

Dole stresses that outsourcing is just a tool, not a cure-all. "It's one of the tools that companies use in connecting their business processes to their strategy," he adds. "Every company has a different idea about what is critical for them to keep and what they don't need to keep."

There may be some companies that outsource, but aren't sure about their reasons for doing so. "You can end up a year later and maybe have spent a little less on the outsourced project, but did you really get what you wanted?" asks David Partridge, vice president of the financial-services practice for Towers Perrin in San Francisco. "You've got to have that road map in place."

To prevent problems, decide what you want from an outsourcing partnership ahead of time, and define those expectations specifically in your mind and in the contract, say outsourcing experts. Make sure that there are safeguards, such as being able to opt out of the contract for noncompliance. It's important to define, for example, what you mean by noncompliance. Make sure that there are specifications regarding daily, weekly and monthly communications and reports. If an outsourcing company doesn't perform to the letter and within the spirit of the outsourcing partnership as defined in the contract, don't be afraid to terminate the relationship. It's your company and, therefore, your terms that are important. "If it isn't done before going in the door, it invariably creates problems," says Partridge.

The key to good outsourcing is setting up a good working relationship from the beginning. "It's all in how you set it up up-front," says Patricia Deschler-Griffin, vice president of outsourcing for Adia's outsourcing division, based in Menlo Park, California. "When you have a healthy alliance, you work through the problems and issues that occur, because obviously, [problems] can [arise]."

In spite of the best intentions and planning, you may have to end an agreement with an outsourcing vendor. Before you terminate a relationship with a vendor, however, realize that you probably will have invested months, if not years, in an ongoing relationship. Much will have changed in that time, especially if you have eliminated in-house staff, as most companies that outsource do. You probably no longer will have the internal expertise to carry on the function for very long without an outsource vendor, so you'll need to proceed cautiously.

"A decision to outsource must be made with the long-term future in mind. Outsourcing simply to avoid or to solve a short-term problem could result in serious consequences. Companies often spend money in developmental and implementation costs in anticipation of outsourcing, and need to recoup those costs over time."

Other important areas for goal setting involve the issue of management time allocation. If your goal is to completely walk away from a function once you outsource it, you might want to think again. Because companies typically downsize a staff function once it's outsourced, someone still will have to spend time overseeing the overall process, even if a manager is no longer overseeing it on a day-to-day basis.

One corporate benefits director of a Fortune 50 company discusses the two-year research-and-planning process that took place before his company's senior management decided to outsource its retirement, savings-plan and ERISA compliance functions. "We've seen both successful and unsuccessful outsourcing projects where companies have turned over administration to a third party and walked away and it's failed," he says. "You can't walk away. You've got to manage your vendor."

Senior management also needs to be aware that outsourcing doesn't mean that managers no longer will be needed. During the outsourcing decision-making process, the benefits director at the previously mentioned company kept senior management informed about the goals for outsourcing and what would be needed in terms of management staff. "I have made it a point to stress to senior management the importance of ongoing staff and ongoing management of the vendor," he says. If you don't, and it fails, there are serious consequences. "Once you outsource, you don't take it back in-house easily. You don't go out and reacquire that expertise you have today, overnight. You also don't fire a third-party vendor overnight."

Perhaps no one is more acutely aware of the problems of a failed outsourcing partnership than Kathryn Devos, manager of employee services for Madison, New Jersey-based Schering-Plough Corp. The first outsource vendor that she hired five years ago in the relocation area caused a virtual disaster.

Even though Devos had specified certain performance criteria in the contract with the relocation vendor, a few years down the line, the criteria weren't being met. "A contract is just a contract," says Devos. "It's just a piece of paper. Although we had a contract, the performance standards weren't being met."

One of the major problems that Devos had with the relocation vendor was the issue of who was in charge. At one point, the vendor representatives began to think that they knew more than Devos did about her company and about how things should operate. "It's the hardest thing because sometimes outsourcing vendors become complacent," she says.

"I gave them a certain amount of time to correct the issues. When they weren't met, it was sayonara," she adds. The next time around, Devos was even more diligent about making her specifications clear from the outset. So far, the relationship is working out better this time. Devos says of the experience: "I've been through both changing outsourcing vendors and a divorce. The divorce was easier."

Don't be shortsighted when making an outsourcing decision.Most companies outsource with long-term objectives in mind. Others, however, outsource only for a year or two, with the idea of bringing the function or process back in-house in the future when they can buy improved technology or again can commit the internal resources to the task.

"Willingness to outsource depends on an HR professional's responsibility level. Often, VPs of HR are more willing to outsource than managers. Overcome objections with facts based on sound business strategies."

It's important to think about these issues before you outsource, because often outsourcing can cost a lot in start-up costs. "If this were a short-term, two-or three-year decision, it certainly wouldn't be a good investment because of the developmental and implementation costs," says the benefits director who's about to outsource. "The intent is that you forecast for the future. As you have a vendor give you long-term cost projections, you sign a contract that safeguards against future inflation and is cost-beneficial to your company."

Saving money is another long-term objective, but it isn't the only factor. "From time to time, we'll talk to organizations where cost is the number-one factor. But more often than not, it's the other factors like the speed, flexibility, consistency of delivery, the ability to react on a dime—that really are an organization's long-term objectives," says Mark Mitter, the defined-benefit administration practice leader for Hewitt Associates. "In this economy, there's clearly more pressure for organizations to look at how they can trim head counts and how they can save money, but there are certainly many organizations in which saving dollars immediately isn't the highest priority."

Increasingly, companies are outsourcing more than one area, thereby buying what are known as bundled services, according to a survey by New York City-based Towers Perrin on outsourcing within the benefits function. If they're going to outsource many areas at the same time, it's essential to conduct a pre-outsourcing audit that defines what the current processes are and how those might be changed or integrated once they're outsourced. Tunnel vision could result in duplicated efforts down the line. "Companies really want to look at outsourcing from a consistent, coordinated effort," says Mitter.

Lillian R. Gorman, executive vice president and HR director of Los Angeles-based First Interstate Bancorp, outsourced her company's entire benefits department to Towers Perrin along with the 401(k) plan nearly two years ago. Another vendor was taking care of the 401(k) at the time, but Gorman gave it to Towers Perrin when she made the decision to outsource the benefits department because of the better deal that she would get by outsourcing both functions to the same vendor. In addition, there was the issue of greater efficiency by having two areas handled by the same vendor.

Gorman signed a two-year contract with the vendor for both areas. "We have every intention of working toward a second contract," says Gorman, who considered both the short-and long-term when she made the decision. "It's just that [outsourcing the benefits function] was so new an idea that neither Towers Perrin nor ourselves wanted to get into it forever," she says. "On the other hand, we wanted it to last long enough to work out the bugs so that the start-up costs associated with it made sense."

Senior staff members often are more willing to outsource than lower-level managers.According to the Towers Perrin report, willingness to outsource differs significantly by responsibility level. The report compared the willingness of human resources professionals to outsource within three different areas of benefits administration—defined benefits, defined contribution and health and welfare.

For all three plans, the survey found that human resources vice presidents and managers are more willing than benefits vice presidents or managers to outsource planning activities (in most cases, they're twice as likely to be interested in outsourcing)

The same holds true within the areas of defined-contribution and health-and-welfare plans for outsourcing of government compliance and written communications

Benefits managers are slightly more willing to outsource record keeping for defined-benefit and health-and-welfare plans than HR managers.

The problem is that many managers at the lower levels can't see the bigger picture or aren't anxious to see their jobs possibly eliminated. You can overcome objections with facts based on sound business strategies.

"I get probably five to seven calls a week from the CEO level interested in outsourcing," says Dole. "The CEO will say, 'I just don't need to own this.' " As the typical scenario unfolds, the CEO discusses his or her interest in outsourcing to the manager responsible for that area. That manager often will build a case about why it shouldn't be done. "It's kind of like putting the wolf in the hen house to guard the chickens," says Dole.

"Most people are afraid of [outsourcing] simply because it looks on the surface that it tends to eliminate your job," says Devos. "It doesn't." If corporate people don't go along with it, they're going to be left behind, according to Devos. "I've noticed it in quite a few corporations where the corporate people haven't gone along with outsourcing, and pretty soon an outsourcing vendor has come in and convinced their senior management that it can do things better, cheaper and more efficiently. Then they're sort of relegated to bystander status."

Devos' observations seem consistent with current research on the subject. According to a recent survey by the Relocation Compass, 50% of corporate staffs view outsourcing as a threat.

The best way to look at outsourcing is from a business perspective, say outsourcing experts. It may be an option that should be considered because it will help streamline processes or help the business succeed. It's difficult to argue with these kinds of solid business reasons, regardless of the management level from which you're viewing it.

Loss of control is a big concern.Outsourcing represents a new business paradigm in which companies decide to focus on their core competencies. All other activities are peripheral and therefore, are nonessential.

"It's a permanent shift in the way companies are going to do business, and the human resources element of it [has been] permanently changed," says Dole. "It's a great opportunity for those who embrace change. But it's going to be a horrible experience for those who are in fear of change."

Many respondents to the recent Relocation Compass survey expressed concern that their companies would lose control over running their own departments if they outsourced. In fact, someone still must oversee the process, even if it's no longer down the hall or in the next building.

For example, Devos outsourced relocation, but the vendor team is on-site at Schering-Plough's Kenilworth, New Jersey, offices. She also outsourced service awards, but directly oversees the work. "We still maintain a great deal of control, simply because we care about our employees," says Devos. "The bottom line is, you still have to answer to your own employees, no matter who does the work."

"HR professionals don't lose control over the function or functions that they outsource. Although the process will never be the same as performing the task in house, HR still must oversee the activities of the outsourcing vendor, and therefore, is still in control of it."

Devos says that she's noticed more companies within the relocation industry turning to outsourcing. "This is the way things are going to go, and if corporate people don't go along with it, they're going to be left behind."

"In the end, [the loss of control] is probably the highest barrier people have," says Dole. "For a lot of them, it's like trying to do a high jump at a height they've never jumped before. Some people run up to the bar and stop. Some run up to the bar and knock it over. Some run up to the bar and leap over it."

Losing control because of outsourcing is an issue with which many managers struggle. The reason, according to Dole, is that they're used to the traditional business paradigm. He says that the new business paradigm, however, is "matrix-oriented," which involves using strategic alliances that help an organization move more quickly and deal with change more rapidly. "For those who can't make those decisions, they've got a lot more problems than whether they should outsource. They've got problems on how they're going to compete, because their culture hasn't shifted yet," says Dole.

To support outsourcing, a corporate culture must be open to change."Some companies don't trust outsiders and want to do everything themselves," says Partridge. "For example, the company that has a company cafeteria and company cars doesn't usually outsource too much. But companies that try to run absolute minimum in terms of what they've got to do to be great in their own business tend to be the ones who outsource."

Sometimes a change in corporate structure will prompt or support an outsourcing climate. At First Interstate Bancorp, for example, the entire company structure was re-engineered in 1991. "We restructured our whole company into regions," says Gorman. "We had a culture prior to this restructuring that was very entrepreneurial and independent state by state, and that meant a lot of duplication."

During the restructuring process, the bank's human resources department also re-engineered itself. "We looked at how we could do HR better and more cheaply throughout the company," says Gorman. "We came up with a common structure that put all of the policy-and-program development on behalf of the whole culture in one place." Specifically, she centralized the design areas of human resources and decentralized the administrative tasks.

"Most companies that have outsourced have done so either because it's consistent with their culture or because they had a particular need that they were responding to," says Partridge.

Some companies have no problem outsourcing some areas, such as the more administrative tasks, but wouldn't consider outsourcing the design elements as First Interstate did with its benefits-design area. For example, Devos says that Schering-Plough is a very paternalistic corporation, and there probably are many functions that it would never let go of.

It's smart to communicate your company's culture and its approach to process and functional design to your outsourcing vendor. Says one outsourcing expert: "You've got to outsource to people who know the kind of culture you want to develop within the company." He notes that the problem with corporate cultures is that they're evolutionary. "The character of the company will change over time, perhaps in a different direction," he says. "So, for the first little while, there's probably no change, and you're probably better off for having outsourced. But three or four years down the road, will it be? If you're a really small firm, it could be a good idea. If you're a decent-sized company, you might end up paying quite a price for doing that."

"Whether outsourcing a function such as benefits administration fits into the overall corporate culture depends on how an outsourcing relationship is viewed and implemented. If the transition is seamless, a company will experience only the benefits, such as better service or faster responses to questions."

It's true that corporate cultures are constantly changing. However, this shouldn't prevent companies from reengineering themselves so that every function operates at its greatest efficiency. Says Carl Nielson, HRIS manager for Dallas-based Frito-Lay, a company that recently initiated a re-engineering effort for the entire HR department: "The mission in human resources is to create a team-oriented, owner-based and performance-driven culture. Eliminating administrative processes or pushing those processes out allows us to concentrate more on our true mission. That's what it's all about." He says that human resources at Frito-Lay wants to concentrate on re-engineering its processes to fit the company's employee self-service concept, rather than just trying to improve existing systems. "That has a lot to do with the whole culture," he says. "So, for example, where we used to not have systems that an employee could access, we now have benefits enrollment over the telephone."

Centralized operations may be an easier base from which to outsource.Whether it's better to outsource when your organization has a centralized or decentralized human resources department depends on which area you're considering outsourcing and how the function already operates.

The Towers Perrin survey highlights some of the problems that decentralized companies face when outsourcing benefits activities. The problems include:

Inadequate level of knowledge in divisional human resources personnel

Too much turnover at the division level

Poor quality and consistency of communication

Benefit personnel too task-oriented, not enough people looking at the big picture

Costs and staff levels for benefit functions and programs almost impossible to judge accurately

Difficult to attain consensus on design policies and issues

No direct-reporting relationship between corporate and divisions; cooperation is a lost cause.

By contrast, the problems faced by centralized companies include:

High level of bureaucracy leading to feeling out of touch with employees

Extensive staffing constraints due to easy monitoring of growth in staff size

Unsatisfactory handling of employee inquiries

Managing a large administrative staff diverts time from planning and the big picture.

Clearly, centralized and decentralized functions each represent their own unique challenges. Some problems, however, have nothing to do with centralization levels; they stem from the reporting structure or from the plan or functional structure, according to the Towers Perrin report.

The benefits director who's about to outsource three headquarters-based areas of his company's human resources function thinks that it's better to start with a centralized operation before outsourcing. "We have a common, central administrative function, therefore, we have common administrative practices and common interpretation of plan provisions," he says. "It reduces costs significantly to hire a vendor to work with one staff versus having a series of interfaces between different administrative offices. It also offers that many fewer opportunities for failure."

There's a growing trend toward centralization in certain industries. According to the Relocation Compass, for example, there's a trend developing among many companies to centralize their relocation departments. It reports that no fewer than eight corporations located in one metropolitan area have recently centralized.

According to another survey of corporate relocation policies conducted by Evansville, Indiana-based Atlas Van Lines, 85% of companies administer employee relocations from a centralized department, and 15% from decentralized departments.

"The ease of outsourcing within a centralized or de-centralized HR function depends on several factors,. Companies with decentralized operations can benefit from the increased speed, flexibility and innovativeness that outsourcing can provide. Centralized operations can benefit from outsourcing because HR then can devote more time to their companies big picture."

"What we're hearing is that most organizations—particularly larger organizations that may have decentralized administrations—are feeling that an outside organization [an outsource vendor] has much more ability to react in terms of speed, flexibility and innovativeness in consistency of delivery," says Mitter.

In other cases, such as with Frito-Lay and First Interstate Bancorp, outsourcing coincides with a larger structural reorganization. According to the Hewitt Associates survey, 23% of the surveyed employers named "organizational shift"—which included centralization/decentralization, work-force reduction and the changing human resources role—as a reason for outsourcing.

In the end, companies that conduct a complete review of their human resources structures, processes and procedures will have the kind of information that they'll need in order to make an informed decision about whether to use outsourcing as a tool for process innovation.